Composer Maria Schneider has used ArtistShare to raise money from fans to produce CDs.

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After she returned home to San Francisco, her thoughts kept drifting back to the faint but enduring idea of producing a clothing line that used textiles and talent from the West African country. She had few concrete plans on how to start a business — and even less money.

Then, a chance encounter at a seminar in New York with the founders of start-up RocketHub, a crowd-funding website, stirred her hopes. At the urging and guidance of Brian Meece and Vladimir Vukicevic, Sebold wrote at length about the business idea on RocketHub.com, accompanied by a video, and asked for direct financial contributions from family, friends, and friends of friends.

Her modest goal of raising $4,000 was achieved in about two weeks. Her first set of dresses, funded by the donations and made in Ghana with local labor, sold out online and at local pop-up stores. "It gives you more credibility than saying 'Hey, Uncle, can you lend me $20?' "

Entrepreneurs and dreamers such as Sebold are flocking to crowd funding, an emerging field of finance that, by using the Internet as an efficient middleman, often manages to be both more intimate and more high-tech than traditional means of raising seed money. The idea has existed for years but is receiving renewed attention now that social media, online networks and payment technologies increasingly strip away legal, psychological and logistical barriers for money solicitations.

RocketHub, Kickstarter, PledgeMusic, Funding4Learning, ArtistShare, FundRazr and hundreds of other sites call on individuals to pool their money, by way of the Internet, and support others' artistic, educational and business efforts, as well as charities and disaster relief. Some sites, like Kiva, specialize in small loans.

"The gradual success of many projects has validated this as a real option, a real way to make things," says Yancey Strickler, co-founder of Kickstarter. "The Internet is incredible for harnessing organizational power."

While they get a sense of fulfillment at seeing the campaigns they support continue, donors typically receive neither a stake nor artistic/operational input. That could eventually change. President Obama recently signed a law, the Jumpstart Our Business Startups (JOBS) Act, that would allow individuals to buy equity stakes in companies via crowd-funding sites under certain rules, likely effective next year.

A few dollars here and a couple of hundred bucks there can add up quickly. About $1.5 billion was raised in 2011 by about 450 crowd-sourcing Internet sites worldwide, says a report by Crowdsourcing.org, a site tracking the industry. That's expected to double this year, the report forecasts.

"This expands on the angel investor model" in which a wealthy individual puts up money in return for equity, says David Rubenstein, partner at accounting firm WeiserMazars. "There is some good to this. This will ultimately result in growth of companies and additional jobs."

The business is also good for those who operate successful crowd-funding sites. They make money by taking a percentage of the money raised — typically about 3% to 5% — and a per-transaction fee.

Kickstarter, one of the largest crowd-funding sites, has so far counted $200 million of pledged contributions, though not all were given to fund seekers. Fund seekers on Kickstarter get their hands on the money only if they can meet their goal. If a campaign fails, money is returned to donors. About 20,000 Kickstarter campaigns have met the goal, or about 44% of all campaigns.

Rival RocketHub sees about 1,000 campaigns a month launched on its site, Meece says. RocketHub allows campaign creators to keep the funds they raise even if they fall short of the goal.

Many campaigns, such as for Sebold's Ghana-inspired dresses, are quirky, artistic or creative, but modest in their financial goal. Successful Kickstarter campaigns average about $5,000 in funds raised. "Kickstarter changes the question of funding from 'Is this a good investment?' to 'Do I want this to exist?' And that's a much lower bar," Strickler says.

The JOBS Act will likely raise the financial bar higher for some crowd-funding sites when they start selling equity online next year. While equity deals on crowd-funded sites have been legal in Europe and Australia for some time, U.S. regulators have kept a lid on the notion until now because of concerns about fraud.

Brydge

Brydge, a San Francisco start-up that makes iPad keyboards, has raised $697,000 on Kickstarter.

The Securities and Exchange Commission, which regulates all electronic securities markets, is currently drafting rules for crowd-funded equity transactions. But state regulators already have issued statements warning consumers about risks involved. "I'd like to see regulators put into effect rules to properly protect investors in these small offerings," Rubenstein says.

Still, crowd-sourcing proponents are betting that the advent of another fundraising channel will be a boon to entrepreneurs whose dreams have been kept in check by finances. The number of crowd-funding companies could grow by as much as 60% this year to 540, Crowdsourcing.org estimates. "You're going to see a lot of niche platforms — ones specializing in specific kinds of gadgets or technology," says Kevin Berg Grell, a program director at Crowdsourcing.org.

Keeping donors in the loop

While many donors are happy to give without expecting much in return, perks and frequent progress updates from fund seekers have been key ingredients in the increasing popularity in crowd funding.

Many sites, including Kickstarter and RocketHub, require campaigns to give back a perk — ranging from personally signed postcards and Twitter shout-outs to an invitation to production sites. Blog posts and Twitter updates from project creators also keep donors engaged and help generate more funds, Strickler says. "The projects that have a video succeed twice as often. Effort is just a big part of it," he says.

Steve Taylor, a filmmaker in Nashville who turned to Kickstarter for his feature film Blue Like Jazz after original investors backed out, promised to call any donor who contributed at least $10. His project became one of the most successful Kickstarter campaigns ever, with many fans of the original book by Don Miller chipping in. Some $350,000 was collected, more than double the goal of $125,000. Taylor estimates he made about 3,500 phone calls. "It took about a year to finish all the calls," he says. "I loved making those phone calls. A lot of them wanted to tell me what the book meant to them. Many were mindful that I had a lot of calls to make, so they kept it short. But I never said I had to go," he says.

Fundraisers also often pledge their products as a reward. Brydge, a start-up in San Francisco that is making an iPad keyboard with funds raised on Kickstarter, promises to ship a keyboard to donors who give $170. With the campaign ending on Monday, Brydge has raised $697,000, far surpassing its goal of $90,000. "You have a lot of people who contribute because it's a product they'd want to use," says Sam Gordon, a Brydge co-founder.

Some sites stand out by focusing on niche markets. ArtistShare is an online music studio that also plays matchmaker between musicians and fans who contribute money to their favorite artists. "It was just a long time coming for this idea to take foothold. Our first project won a Grammy, but people didn't put the two together," says Brian Camelio, founder of ArtistShare. "People didn't understand not having a stake in the intellectual property (when they donate money)."

Maria Schneider, an orchestra jazz composer, met Camelio while she was struggling to raise money for her first album in 2001. Using ArtistShare, she says, she raised "over $100,000" that was used to produce the album Concert in the Garden, which won a Grammy in 2004. "ArtistShare gives me a lion's share of the profit. If I sell a CD for $16.95, I'm not splitting it with distributors. So you don't have to sell as much as you used to," she says.

She is now back for her third album, Maria Schneider — Dawn Upshaw Chamber Works, on ArtistShare.

Keeping the scams out

Crowd-funding sites vary in how they handle money. The intersection of crowd sourcing, money and anonymity afforded by the Internet may sound like a cesspool of financial chicanery and frauds, but site operators are sensitive to the perception.

Kickstarter's all-or-nothing approach to money — donors aren't charged if campaigns fail to meet their financial goals — helps to minimize fraud, Strickler says. The rule forces entrepreneurs to be realistic about their projects and how much they need. "Groups make pretty good decisions," he says.

RocketHub allows fundraisers to keep the funds even if they fall short of their goal. But the company saw no need to withhold money, because it found 75% of funds raised on its site are from someone you know or others who know people in your network. "You have a built-in safety mechanism. People who don't have social capital aren't able to fundraise online," Meece says.

RocketHub also has a more laissez-faire approach to campaign submissions, allowing any and all to display so long as they are legal and of good taste. Kickstarter rejects project submissions that it deems inappropriate.

But scams and never-materialized projects sometimes pop up in crowd funding. In one notable case, a video game campaign raised nearly $5,000 on Kickstarter before "the studio" was discovered by forum users at social news website Reddit to be a fraudster. The campaign was eventually canceled by its creator.

James Portnow, a game designer in Seattle, is a critic of Kickstarter's "curation" approach. "I've seen a number of (video) games in Kickstarter that aren't within the scope of what they're raising funds for," he says.

Last year, Portnow sought to raise funds to help pay for a colleague's medical bill, but his campaign was rejected by Kickstarter because, he says, "It wasn't an art project."

Portnow took his campaign to RocketHub and raised more than $100,000, far more than his goal of $15,000. Portnow says he plans to invest the rest on other game entrepreneurs. "I feel a huge responsibility for the money we've raised," he says.

——

JOBS Act brings opportunities, worries

New opportunities are emerging for those who fancy themselves cash-poor but discriminating venture capitalists. Others see a door opening for scams.

The Jumpstart Our Business Startups (JOBS) Act, signed into law by President Obama last month, contains provisions that allow startups to sell individuals an ownership stake in the company of up to $1 million on crowd-funding websites. The Securities and Exchanges Commission must draft rules for how that will work before the law goes into effect next year.

"Who are the investors for this? They are lay persons on the street. These investments have had all sorts of problems and frauds," says David Rubenstein, partner and chair of SEC practices at accounting firm WeiserMazars.

With rulemaking still ongoing, the law lacks details on how investors will be protected. But broadly, it imposes certain rules on funding websites, including a requirement that they refrain from directly handling money or securities. They must hire an intermediary, such as a bank or broker, for such transactions. The funding sites are also prohibited from making security recommendations or promoting a particular company.

The banks and brokers are required to conduct background checks of officers or directors holding at least 20% of company shares. A crowd-funding site can also act as an intermediary — and hold funds and securities— if it registers as a broker.

Because most crowd-funded deals are small in size, large brokers could be tempted "to cut corners," Rubenstein says. Smaller intermediaries may not have enough resources to meet the requirements, he warns.

— Roger Yu

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